Can you find serenity in investing?

The serenity statement can be very helpful in investing. It can be found in various guises in different religious and philosophical traditions, and goes something like this: Grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference. It’s a waste of time and energy to try to affect the things we can’t change, and better to focus on the ones we can. This is true in investing as in life.

When thinking about a portfolio, investors often consider the rate of return to be the important factor in how large the portfolio can grow over time. The unfortunate fact is that there is nothing investors can do about about the market return. Stock markets rise, they drop, and no one knows when that will happen or what the magnitude of each will be. As of right now, February 2018, the current bull market which began in 2009 (or in 2011 depending on how you measure it) is the second longest bull market in history. Many in the financial field have been calling for its demise for the past several years, and yet it continues to run. We do know that it will end at some point, but no one knows when, and how much higher it will go until then. Over the long term, stocks have averaged 6-8% over inflation. We also know for a fact that stocks will not provide these returns every year. Though market returns are an important factor in the growth of the portfolio, they fall firmly in the “things we can’t control” camp.

Smaller factors in portfolio growth include taxes and fees. Both of these must be paid in one way or another. If you don’t pay taxes now, as on traditional retirement accounts, you will pay them later when you take the money out. You will have to start making required distributions at the age of 70 ½ (and paying taxes on them) from these accounts, unless you’re still working for the employer that sponsors the retirement plan. Tax rates are set by Congress, so you can consider candidates’ tax policies at the voting booth, but as always, it’s a bad idea to let the tax tail wag the dog.

Having money in the market in one way or another requires money management firms to do some work on your behalf, and they expect to be paid for this work. As you do with taxes, you can consider the fees you will have to pay for various alternatives and bear them in mind when making your selections. Though again, similar to taxes, most decisions shouldn’t be made purely on the basis of fees, unless you’re choosing between two completely identical options and one has a higher fee than the other. Paying taxes and fees is something you can’t change, though you may have some choices as to when and how you pay them.

What are the things you can change? At a high level you have control over how much risk you take in the portfolio, bearing in mind that there are more risks than just a stock market drop: the risk of inflation, in which your expenses rise over time; and interest rate risk: the risk that interest rates will rise and as a result the bonds you hold are less valuable. Interest rate and inflation risks are less suddenly dramatic than the risk of a stock market drop, but they can still damage your ability to reach your goals if not taken into consideration when putting together your asset allocation. Cash is excellent as a hedge against near-term stock market drops, and so you should have an emergency fund of three to six month’s expenses in cash. If you’re retired, you may want to have a year’s worth of expenses in cash. However, inflation eats away at cash and so it is a bad idea for money you will need over the long-term. Even once you have retired, you still probably have a long-term time horizon over which your funds need to last. For example, if you retire at age 67, you could live to 87 or longer. Bonds help provide a cushion against stock market drops in the medium term, because you will at least be paid interest to hold the bonds. However, interest rate risk means that bonds are a poor hedge against longevity. Stocks are the best choice over the long term because of those long-term market averages and hedge against both inflation and interest-rate risks. However, the risk that the market could suddenly drop just when money is needed, makes stocks a poor option to cover near-term expenses.

It’s important to balance these risks in a way that you can maintain over the long-term, so that you’re not constantly selling your stocks when the market drops or your bonds when interest rates rise. Since it’s not possible to know when the stock market will rise or fall, you can’t count on being able to sell out or buy in at the right times. You’ll therefore need an allocation that you can hold onto whether the market is going gangbusters or when it’s dropping. It’s normal to feel some discomfort when the market is dropping, but you need to stick to your allocation and your buying program if you purchase every month (dollar-cost averaging, typical with retirement accounts). When the market is soaring, it’s easy to think that you should be taking more risk, and increase your stock allocation or buy more risky stocks. Bear in mind that you’re buying high in this case! However, at some point the market will come back to earth. If you increased your stock allocation during the boom times, then you have more exposure to the market drop and may feel pressure to sell, at a loss. Once you’re closer to needing money from your portfolio (for example, within a few years of retirement) you might want to increase your cushion of cash and bonds, but you will still need some long-term money in stocks to carry you through retirement.

Another item within your control is spending. Unless your income is at or below the poverty line, you likely have some expenses that can be adjusted if necessary. If you feel like you can’t get ahead of your bills and save money, look at your expenses and see what can be cut. Although you need to pay your rent or mortgage, you can get a smaller place that doesn’t leave you house poor. Small changes can reduce your expenses on utilities – turn lights off and unplug electronics when not using them, use curtains to block out the sun’s heat in the summer, etc. You can shop around for better deals on insurance, Internet service, cellphones and cable TV, which you can get rid of entirely and use streaming devices instead. If you need to buy a new car (and current cars can easily go for a decade without being replaced), consider gas mileage as a major purchasing factor.

Obviously entertainment and food are categories to consider. Are there ways to reduce the expenses, or substitute for them? At the grocery store, there are numerous products where the store brand is just as good and much cheaper than the brand name. This does take some experimentation – I had a very bad experience with supermarket cheese once. But things such as beans, canned tomatoes, and the like work pretty well. If you enjoy sports, maybe you can join a recreational league and go out with your teammates after games, instead of paying to attend a pro game. If you enjoy the symphony (as I do) you might be able to usher for free, and still listen to the music. And if there are certain areas where you really need a premium experience, think about where you don’t and cut back there. For example, if good cheese is important to you but coffee is less important, you could buy the cheaper brand of coffee and the better cheese and not feel deprived.

In other words, have the serenity to accept that you can’t change the market returns, but you can change how much risk you take to get to a good asset allocation, and how much you spend, to make sure you have money to add to the portfolio over time.